Friday, March 20, 2015

Current and future state of lamb markets – did we get it wrong?

Key points

Although lamb supply until June may be stronger than previously expected, numbers should start to contract considerably when the autumn breaks.

Dry conditions continue to force lambs out of the paddock and discourage ewe lamb retention.

Export markets struggling to digest temporary supply glut from Australia and New Zealand.

Most downside forces will gradually subside in the months ahead, perhaps rapidly under a solid autumn break to support much firmer lamb prices.

Since the start of the year we have been saying lamb markets were going to move another leg higher underpinned by favourable supply/demand fundamentals in autumn/winter. So far, that scenario has not eventuated. In fact, lamb prices have actually moved back to last spring’s lows. This has triggered us to re-evaluate our lamb market outlook for the months ahead, to realise things aren’t as bleak as they seem.

So what went wrong? To start, there are a few things at play right now that we could not clearly foresee earlier in the year, and those are placing some strong downside pressure on markets. The first one revolves around supply. Although we did not think lamb slaughter would fall as much as MLA suggested in its industry forecasts, we still anticipated numbers could easily fall by 5-7% below year-ago levels between February/June.

So far, lamb turnoff continues to run quite strongly, with numbers tracking around 1.5% above the record levels of 2014, and 17% above the 5-year average (figure 1). This is surprising as there has been a general consensus the lamb crop contracted in 2014/15 because of a smaller flock, while reported marking rates remained relatively steady. Flock rebuild efforts should start to gather momentum once seasonal conditions improve.

Last week, ABARES published its medium-term forecasts and defied that assumption, estimating lamb slaughter would continue to track around year-ago levels until June (figure 2). That seems overly optimistic. These forecasts not only assume a larger lamb crop than in 2013/14, which seems unlikely. However, it also potentially underestimates the number of ewe lambs that would be held for breeding purposes in order to rebuild the flock.

On the demand front, there has been some general talk about softening export demand in recent weeks, but in our view that’s a temporary issue. Both New Zealand and Australia continue to export record volumes of lamb meat. This has created a temporary supply gut in global lamb markets; however, it does not mean export demand is softer. From what we know, overseas demand is unlikely to wane in the foreseeable future.

Another important thing to mention, and gets overlooked sometimes, is the potential benefits to be generated from a lower A$. Last year, the Eastern States Trade Lamb Indicator (ESTLI) peaked at A600¢/kg cwt, or US550¢. This Thursday, the ESTLI is quoted at 495¢/kg cwt, or US380¢, which is 30% below last autumn’s highs in US$ terms. On the flipside, at current exchange rates, last year’s peak equates to A715¢/kg cwt.

What does this mean?

If we look beyond the “current price signals” and critically analyse the prospective supply/demand fundamentals for autumn/winter, the main conclusion we get is that the market is currently oversupplied and undervalued, but that will have to come to an end. Although we might be a bit less bullish about the potential upside for lamb prices than before, we remain very upbeat about the market outlook.

Up until now, the key positive price drivers – outlined below - remain “in the making”, and have not yet converged to give lamb markets the expected upside. That said, it will be only a matter of time before they conspire and quickly become catalysts for price rises.

1. Supply of grainfed lambs, and stock carried on summer crops, to fall considerably in the coming months as a result of anticipated sales this year.2. Delayed autumn break to halt supply of grassfed lambs and finally support ewe lamb retention.3. Temporary “supply glut” in export markets to subside quickly from April onwards to support much firmer export prices.4. Benefits from a lower A$ will only generate a positive impact domestic prices when numbers tighten.

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